3.4 market structures

Question 1

Allocative efficiency

Answer 1

-resources are used to produce goods and services which consumers want and value most highly
-social welfare maximised
-occurs when P = MC

Question 2

Productive efficiency

Answer 2

-when products are produced at the lowest average cost so the fewest resources are used to produce each product
-minimum resources for maximum output
-can only exist if firms produce at the bottom of the AC curve
-in the short run this is where MC=AC

Question 3

Dynamic efficiency

Answer 3

-resources are allocated efficiently over time
-concerned with investment which bring new products and new production techniques
-competition encourages innovation
-supernormal profit is required to provide firms with the incentive to invest and the ability to do so

Question 4

X-inefficiency

Answer 4

-when a firm fails to minimise its average costs at a given level of output
-not producing at the lowest on the AC curve
-often occurs where there is a lack of competition so lack of incentive to cut costs

Question 5

perfect competition characteristics

Answer 5

-many buyers and sellers
-no barriers to entry/exit
-perfect knowledge
-homogenous products

Question 6

perfect competition efficiency

Answer 6

-productively efficient since MC=AC
-allocative efficient since they produce where P=MC
-not dynamic efficient since no single firm will have enough for research and development and since small firms struggle to get finance

Question 7

what profit is made in perfect competition?

Answer 7

-in the short run supernormal
-in the long run normal

Question 8

monopolistic competition examples

Answer 8

-hairdresser
-estate agent
-restaurant

Question 9

monopolistic competition characteristics

Answer 9

-large number of buyers and sellers
-no barriers to entry or exit
-differentiated, non-homogenous goods
-only make supernormal profits in the short run and normal in long run

Question 10

limitations of monopolistic competition model

Answer 10

-information may be imperfect so firms will not enter the market as they are unaware of these abnormal profits
-firms are likely to differ in size and and cost structure as well as their products, which allows some firms to keep supernormal profits as firms can not compete on equal terms

Question 11

efficiency of monopolistic competition

Answer 11

-not allocatively or productively efficient as MR=MC instead of MR=AR and since they profit maximise MR=MC so MC can’t equal AC
-likely to be dynamically efficient as there are differentiated products so innovated products will give them an edge over their competitors
-however since the businesses are small they may struggle to receive finance or have retained profits necessary to reinvest
-compared to perfect comp, less is sold at a higher price and firms may not be producing at the lowest cost however there will be greater choice for consumers and firms. can benefit from economics of scale

Question 12

oligopoly definition

Answer 12

when there are a few firms that dominate the market and have the majority of market share

Question 13

oligopoly characteristics

Answer 13

-products are generally differentiated
-high concentration ratio
-interdependent firms
-high barriers to entry

Question 14

concentration ratio formula

Answer 14

total size of n firms/ total size of markets x 100

Question 15

collusion

Answer 15

when firms make collective agreements that reduce competition

Question 16

What is the problem with the linked demand curve theory?

Answer 16

-assumes there is an initial price set within the market and does not explain why this price was sat
-however it does explain why prices tend to be stable

Question 17

What is an example of an industry suspected of collusion?

Answer 17

The UK energy market

Question 18

Why would firms collude

Answer 18

-working together, they could maximise industry profits
-reduces the uncertainty that firms fqce and reduces the fear of engaging in competitive price cutting or advertising which will reduce industry profits

Question 19

Why may firms not want to collude?

Answer 19

-collusion is illegal
-risks of collusion e.g the other firms might break the cartel or prices may be set where they don’t want it

Question 20

What firms won’t want to collude?

Answer 20

-those with a strong business model and something that sets it apart from other firms ad they feel they can increase market share and/or charge higher prices than competitors

Question 21

When does collusion work best?

Answer 21

-there are a few firms which are all well known to each other and the firms are not secretive about costs and production methods are similar
-they produce similar products
-there is a dominant firm which the others are happy to follow
-the market is relatively stable
-high barriers to entry

Question 22

Overt collusion

Answer 22

Firms come to a formal agreement

Question 23

Tacit collusion

Answer 23

No formal agreement

Question 24

What is a cartel?

Answer 24

A formal collusive agreement and firms who enter mutually set prices
-rules are laid out in a formal document which may be legally enforced and fines will be charged for firms who break these rules

Question 25

Problems with a cartel

Answer 25

-no firm is likely to set their prices/output at the level they would not ideally choose so there is constant temptation to break these cartel -the more successful the cartel, the greater the temptation to break it -important firms break it first and not be the firm to deal with after effects

Question 26

Price leadership

Answer 26

-Where one firm had advantages due to its size or costs and becomes the dominant firm -Other firms will follow as they will be fearful of taking on the firm in a price war -As a result the dominant firm will decide the price and allow other firms to supply as much as they wish at this price

Question 27

Non- collusive oligopoly

Answer 27

-Behaviour will depend on how it thinks other firms will react to its policies -Game theory can be used to examine the best strategy a firm can adopt for each assumption about its rivals

Question 28

What is game theory?

Answer 28

Explores the reactions of one player to changes in strategy by another player

Question 29

Price wars l

Answer 29

-occur in markets where non price competition is weak -drive prices down to levels where firms are frequently making losses -lowers industry profits -e.g supermarkets

Question 30

Predatory pricing

Answer 30

-occurs when an established firm is threatened by a new entrant or if one firm feel that another is gaining too much market share -established firm will set such a low price that firms are unable to make a profit so are driven out the market -illegal and only works when one firm is large enough to be able to have low prices and sustain loses

Question 31

Limit pricing

Answer 31

-in order to prevent new entrants, firms set the prices low but high enough for them to make normal profit but low to discourage new entrants -the greater the barriers to entry, the higher the limit price, mainly used in contestable markets -drawback is that firms can not make profits as high as they would be able to otherwise

Question 32

Non price competition

Answer 32

-advertising -loyalty cards -branding -quality -customer service -product development

Question 33

Problems with non price competition

Answer 33

-often expensive -no guarantee that it will be successful

Question 34

Characteristics of a monopoly

Answer 34

-pure monopoly is where one firm is a sole seller of a product in a market **one of the closest examples is google who have 88% of the market** -firm can legally be considered as having monopoly power if it has more than 25% of the market -high barriers to entry **tesco is a legal monopoly with 28% market share**

Question 36

Third degree price discrimination

Answer 36

-monopolists charge different prices to different people for the same good or service **e.g train tickets with discounts for students** -the firm must be able to clearly separate the market into groups of buyers; the customers must have different elasticities of demand; and they must be able to control supply and prevent buyers from the expensive market from buying in the cheaper market

Question 37

Costs and benefits of price discrimination

Answer 37

-firms benefit since they can increase their profits which can go into research and development, improving dynamic efficiency -those in the elastic market gain as they are able to pay a lower price than they otherwise would; benefitting from cross subsidisation; may increase equality if they would’ve otherwise been unable to access the good -consumers lose some of their consumer surplus to the producers and consumers have to pay a higher price

Question 38

Natural monopoly

Answer 38

-the economies of scale are so large that even a single producer is not able to fully exploit all of them -none in real life **examples include the national grid, Royal Mail, national rail**

Question 39

Drawbacks of natural monopoly

Answer 39

-pointless to encourage competition since it would raise average costs for the industry -very high fixed costs -not allocative or productively efficient as there is no minimum on the AC curve what allocative efficiency there would be a loss

Question 40

Costs and benefits of monopolies to firms

Answer 40

-monopolies have potential to make huge profits for their shareholders through profit maximisation -firms will have finance for investments from the existence of supernormal profits -firms can compete against large overseas organisations -large firms can maximise economies of scale, reducing costs and increasing profit further -however, firms may not always choose to profit maximise because of X-inefficiencies -in long run the lack of competition may mean that firms become complacent and so they may not make maximum profits

Question 41

Costs and benefits of monopolies on employees

Answer 41

-monopolists produce lower outputs, so will employ fewer workers -however the inefficiency of the monopoly may mean employees receive higher wages particularly directors or senior managers

Question 42

Cost and benefits of monopolies on suppliers

Answer 42

-the impact will depend on the extent to which the monopolist is also a monopsonist -if the monopolist buys all or most of the supplies goods (so is a monopsonist) it will reduce the supplies profits as the monopolist will decrease prices

Question 43

Cost and benefits of monopolies on consumers

Answer 43

-firms enjoy economies of scale, and consumers will enjoy a higher consumer surplus -increased range of goods and services due to cross subsidisation -consumers may pay higher prices and see poorer quality service due to lack of competition may -less choice for consumers, since there is only one firm producing the good

Question 44

Monopoly efficiency

Answer 44

-not productively efficient as they don’t produces at MC=AC -not allocative efficient as P > MC -dynamically efficient as the monopolist is likely to make supernormal profits however with no competition they may have no incentive to invest

Question 45

Monopsony

Answer 45

Only one buyer in the market

Question 46

Characteristics of a monopsony

Answer 46

-only one buyer in the market -pay their supplies lowest price possible to minimise their costs and make the most of their position as the only buyer so they can maximise profit

Question 47

Costs and benefits of monopsony on the firm

Answer 47

-gains higher profits by being able to buy at lower prices -achieve purchasing economies of scale, which will lower costs and increase profits **NHS is a monopsonist buyer of pharmaceuticals, leading to significantly lower prices. As a result, they can invest more and pay for treatments**!

Question 48

Cost and benefits of monopolies

Question 49

Cost and benefit of monopsony on consumer

Answer 49

-consumers may gain from lower prices as reduced costs are passed on to consumers -could lead to a fall in supply since the business buys fewer inputs -they may act as counter weight to monopolists -may be a fall in quality as prices are driven down

Question 50

Cost and benefit of monopsony on employees

Answer 50

-the supplier will sell less goods and so employ less people -many pay higher wages as they are making higher profits

Question 51

Cost and benefits of monopsony on supplier

Answer 51

-supplied will lose out as they will receive lower prices; less will be supplied leading to some firms leaving the market

Question 52

Characteristics of a contestable market

Answer 52

-perfect knowledge -freedom of entry and exit -absence of sunk costs -low product loyalty -assume firms are short run profit maximisers and do not collude **examples include the taxi industry with the introduction of uber and hotels with the introduction of air BnB**

Question 53

Implications of contestable

Answer 53

-have to use limit pricing to reduce the incentive for firms to join the market -in a perfectly contestable market, firms will only be able to make normal profits where AC= AR because new firms would enter if price was higher -likely to be productive and allocative efficient

Question 54

Types of barriers to entry/ exit for contestable

Answer 54

-legal barriers -marketing barriers -price decisions of incumbent firms -high capital start up costs -economies of scale -cost to quote off assets, pay leases and make workers redundant

Question 55

Sunk costs and degree of contest ability

Answer 55

-sunk cost is a fixed cost that a business cannot recover if it leave the industry -all businesses will face sunk costs because even if things are resold it is for a lower price -degree of contestability is measured by the extent to which the gains from market entry for a firm exceed the costs of entering the market -no market is perfectly contestable as there is always some sunk cost